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Cadbury Closing In On Sweet Deal

Posted: Jul 20, 2007 14:23 PM by Eugene Bukoveczky

Tickers in this Article: BX, KFT, TIF, HNZ, CSG

There must have been quite a spot of bother at the head office of one of Britain's oldest and largest companies, Cadbury Schweppes (NYSE:CSG), when it was disclosed last March that U.S. billionaire shareholder activist Nelson Peltz had acquired just under 3% of the company's shares.

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Enter the Activist
Peltz has a reputation for stirring things up in the executive suite. He likes to shake up quality companies that are failing to realize their full potential due to moribund management. By taking a stake in Cadbury, Peltz served notice to management that he plans to push for serious changes in the way the company is run.

The man is no rookie. Last September, after a heated six-month battle, Peltz and his colleague Michael Weinstein, won seats on the board of H.J. Heinz (NYSE:HNZ) and immediately started stressing the company to revise its marketing strategy.

Heinz shareholders liked his involvement as the shares have moved from $33 to their current price of $47 while he's been a shareholder.

More recently, in February of this year, Peltz's hedge fund, Trian Fund Management, took a 5.45% stake in jeweler Tiffany & Co. (NYSE:TIF) and since then its shares have moved from $42 to $55.

The same shift has happened with Cadbury's - from $42 at the announcement of the Peltz stake to the current $53 range. The proverbial cat might already be out of the bag, but investors should still expect further gains in Cadbury's stock.

Management Plans Dramatic Restructuring
It may just be pure coincidence, but two days after the disclosure of Peltz's stake in Cadbury, the company announced that it was selling its North American beverage unit. The consensus view is that the business could be sold for as much as $15.5 billion with the list of potential bidders including a consortium of private equity players comprising The Blackstone Group (NYSE:BX), Cerberus Capital Management and Lion Capital.

Should Cadbury close the sale of its American beverage division, it will then wind up as the largest pure-play confectionery company in the world. That's prompted speculation that the remainder of the business could itself be in play as a takeover. One potential buyer could be Kraft Foods (NYSE:KFT). However, the odds of Kraft making a bid have diminished since it announced it was buying the biscuit division Group Danone for $7.3 billion. Interestingly, Peltz is rumored to have a 3% stake in Kraft as well, possibly matching the holding of another activist investor of note - Carl Icahn.

Cadbury's Breakup Value
So, if a scenario does unfold where Cadbury does get taken out altogether, what would the total per share value be? While its fairly certain that sale of the American beverage assets would provide Cadbury shareholders with between $29 to $30 per share, the bulk of which could be paid out as a special dividend, assigning a value to remaining confectionery business is a bit less certain.

If we accept management's guidance that the company, minus the beverage business, could realize an EBITDA of $1.4 to $1.5 billion next year, then applying the industry average multiple of 11.5-times to this number gives us another $31 to $32 in value per share for a total company value in the $61 to $62 range. (For more insight, see Mergers Put Money In Shareholders' Pockets and Use Breakup Value To Find Undervalued Companies.)

Speculation Aside, Cadbury A Good Long-Term Investment
In the absence of any further news on either front, Cadbury shares have been gradually selling off, hitting the $52 mark recently. Given all the deal rumors swirling around the stock, is it now time to buy?

While betting on a buyout scenario is basically speculation, an investment argument can be found in an alternative possibility - that of a gradual management turnaround of the confectionery business. Since the arrival of Peltz, Cadbury management has committed itself to a major cost-cutting program that could see its margins move up significantly, from about 10% currently to 14% by 2011. If Cadbury can make this happen, then investors might actually be better off holding onto their shares as opposed to selling out at this time.

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By Eugene Bukoveczky

Eugene Bukoveczky is a freelance writer and investment researcher. He holds a CFA designation and has spent several decades working in the investment business in places like Toronto, New York, London and Dubai. He currently resides in Nova Scotia, where, when not writing, he devotes his time to chopping wood, growing his own vegetables, riding his bike to the store, and thinking about other ways to reduce his carbon footprint.

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